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Break the Platts monopoly! Iron ore pricing benchmark diversified futures point price is gradually becoming the mainstream
Jul 1,2020 08:06CST
translation
Source:Futures daily
The content below was translated by Tencent automatically for reference.

SMM Network News: before the listing of iron ore futures, there is no clear spot price reference in the spot market. Domestic steel mills and traders passively accept the dollar index prices released by foreign institutions. With the continuous improvement of market recognition after the listing of iron ore futures, it has gradually become an important reference for daily trading of iron ore dollars and RMB, and a weather vane of global iron ore financial derivatives.

In addition to the traditional hedging function, in recent years, with the emergence of internationalization and the launch of the basis trading platform, it has further enriched the ways of iron ore futures service entity enterprises. In May this year, Baosteel (hereinafter referred to as Baosteel), a subsidiary of Baowu Iron and Steel Group, completed the first cross-border settlement of RMB using blockchain technology with Australia's Rio Tinto Group, with a total amount of more than 100 million yuan. At this point, Baosteel shares and the three major mining enterprises have reached an agreement on cross-border settlement of RMB.

Recall the past, once "the pain of pricing power"

China is the world's largest steel producer, producing 996 million tons of crude steel in 2019, accounting for 53.3 per cent of global output. China is also the world's largest importer of iron ore, importing 208 million tons of iron ore in 2004, with import dependence rising to more than 50 per cent for the first time. In 2015, domestic iron ore imports reached 953 million tons, and the import dependence exceeded 80 per cent for the first time, reaching 83.57 per cent. Until the end of 2019, the degree of import dependence remained above 80%.

The world's high-quality iron ore resources are mainly distributed in Australia, Brazil, Russia and Africa. Imported resources are mainly from Brazil's Vale, Britain's Rio Tinto, Australia's BHP Billiton and Australia's FMG. In 2019, the iron ore output of the big four miners accounted for nearly half of the world's iron ore output. due to the high mineral products, low mining difficulty and advanced mining equipment, the big four miners have obvious advantages in production costs. According to AME, an Australian mining consultancy, the top 10 lowest-cost mines in the world in 2019 all belong to the top four miners, with ore production costs of less than US $20 per tonne. Among them, the production cost of Vale S11D mine is even less than US $10 / ton, and the average FOB cost of FMG's 160 million tons of iron ore is only US $18.60 / ton.

The cost advantage of the non-mainstream ore from India, South Africa, Canada and other places is not obvious due to the scattered source, unstable supply, messy ore grade and composition. In recent years, the import volume has not increased but decreased, and the annual import volume has also dropped from about 240 million tons in previous years to less than 180 million tons at present, and the proportion of imports has also dropped from 35% to about 15%.

"although China's own iron ore resources have large reserves, the overall grade is low and the ore processing cost is high. Due to the increasing requirements of domestic environmental protection in recent years, the cost of mining has increased. " Cai Yongzheng, director of the Nanjing Iron and Steel Securities Department, told Futures Daily that China's original iron ore output in 2019 was 844 million tons, and according to the mineral processing ratio of 3.13, the domestic finished ore output in 2019 was about 270 million tons.

The market predicts that domestic crude steel production will remain at 800-1 billion tons in 2020-2025. According to the ratio of iron to steel, it is estimated that the output of pig iron in the next five years will be 700-800 million tons, and the annual demand for iron ore will be 1.1 billion-1.3 billion tons. Taking into account the impact of domestic ore production and scrap and other factors, it is estimated that the annual need to import iron ore 900-1.05 billion tons. " Cai Yongzheng analyzed and said.

Although China is the world's largest importer of iron ore, it has no say in pricing power.

In the early days (before the 1960s), the seaborne trade of iron ore was very little. with the economic development, the Japanese steel industry rose, but the country was short of iron ore resources. As a result, Japan and Australia signed a long-term contract, Japan provided funds to develop mines, and Australia exported the mined iron ore to Japan, which ensured not only the funds for Australian mining projects, but also Japan's demand for iron ore, achieving a win-win situation.

Japanese steel enterprises pay attention to long-term cooperation with mines, and the long-term pricing mechanism has gradually matured and gradually evolved into a long-term association pricing mechanism. The annual benchmark price shall be determined by negotiations between the mine and the representative steel enterprises, and accepted by the other negotiators, and the long-term agreement price shall be "FOB price with the same increase". Later, due to differences in sea freight rates caused by different geographical locations, Asian prices and European prices eventually came into being.

"the traditional annual long-term association pricing mechanism lacks flexibility and ignores the changes in the spot market during the year. Once the market price deviates from the benchmark price, default occurs frequently." Zhao Xinrui, head of the futures operation room of the Operation Planning Department of WISCO Kunming Iron and Steel Co., Ltd., said that since the 21st century, the infrastructure industry has grown rapidly, domestic iron ore resources are limited and low quality, and the demand for iron ore imports is expanding day by day. China has become the world's largest importer of iron ore since 2003, when Chinese steel companies decided to join the negotiations on global iron ore prices.

At the end of 2003, with the recommendation of China Iron and Steel Association and major domestic iron and steel enterprises, Baosteel became the negotiator of Chinese iron and steel enterprises and formally participated in the negotiation of international iron ore price for the first time. However, Baosteel did not play an important role that year, but Nippon Steel led the iron ore negotiations in 2004, taking the lead in reaching an 18.6% increase in the initial price with Australia's BHP Billiton.

On February 22, 2005, Nippon Steel agreed a 71.5% increase with Vale and BHP Billiton, the biggest price increase in the history of negotiations. Among them, BHP Billiton asked to compensate for the freight difference, and Baosteel successfully persuaded it to give up.

After more than seven months of unusually difficult iron ore price negotiations in 2006, Vale of Brazil and ThyssenKrupp of Germany finalised a 19 per cent increase, higher than the market had expected. Baosteel believes that this price did not take into account China's factors, asked to continue negotiations, after a month of fruitless efforts, can only accept.

In 2007, Baosteel negotiated with Vale to obtain a "first offer price" with a 9.55 per cent increase, the first time a Chinese steelmaker has set a national iron ore price, but has failed to curb the rising price trend.

Zhao Xinrui concluded: "throughout the course of China's participation in the negotiations, due to the low concentration of China's domestic iron and steel enterprises and uneven production capacity, they failed to form effective 'collective action' and could not have enough impact on the three major mines." on the contrary, it has formed a dependence on the producers and has always been in a passive state in the negotiations. "

In 2008, Nippon Steel and Vale reached an agreement on two benchmark iron ore prices. Among them, the southern iron concentrate rose 65%, and the Caracas powder rose 71%. At the same time, Australia's Rio Tinto Group levied sea freight when selling iron ore to Asian steel mills, using CIF (CIF) instead of FOB (FOB), to obtain higher profits, and the principle of "same variety, same increase" and "FOB price" was broken.

In 2009, in the context of the financial crisis, iron ore negotiations are still not smooth. After Japanese and South Korean steel mills confirmed the "initial price" with the three major mines, China did not implement the "follow the trend" rule, did not recognize the 33 per cent decline accepted by Japan and South Korea, and reached a slightly lower price agreement with FMG outside the three major mines. "most of the Chinese steel enterprises still buy Changxie mine according to the agreed price between Japan and South Korea, but the implementation proportion of the long-term association has dropped sharply, and some resources have to be purchased at spot prices, thus breaking down the iron ore long-term association negotiations." Zhao Xinrui said.

It is reported that since 2010, the three major mines began to adjust iron ore prices every quarter or every month through index pricing, using an index that mainly refers to the price trend of the spot market. Many international institutions have launched iron ore price index, including TSI index, Platts index, metal guide MBIO index and so on. In particular, the Platts index has been quoted by mining giants and become the mainstream pricing standard. Later, Platts acquired the TSI Index, which is ahead of other similar service providers in iron ore hedging business, further strengthening its monopoly position.

After the pricing of the iron ore index, it is further financialized, overseas non-industrial institutions are involved in this system, and the huge index and hedge funds regard iron ore as the second largest investment allocation after crude oil. The price of iron ore is virtualized and financialized, which will not reflect the simple value scale of supply and demand and the upstream and downstream profit distribution system, the information asymmetry in some stages of overseas swap iron ore trading, and even become a tool for wealth distribution and transfer.

Compared with the long-term Association pricing mechanism and Platts index pricing, iron ore futures are more fair and transparent. On October 18, 2013, the Chinese version of iron ore futures contract was officially listed for trading in Dashang Stock Exchange. On May 4, 2018, the iron ore futures of Dashang Institute formally implemented the introduction of overseas trader business, which became the opening of China's listed futures varieties to the outside world for the first time. As a result, RMB iron ore moved towards internationalization, and also explored experience for the internationalization of existing varieties in the futures market.

As an old man in the iron and steel industry, in his conversation with reporters, Cai Yongzheng still clearly remembers the situation when the mining negotiation mechanism of the Changsha Association broke down more than a decade ago, and all the "negotiations" and "discussions" were hidden among them. it is not only the gains and losses of one city and one pool in the commercial war, but also the global business discourse, and the rotation and Nirvana of the confrontational mentality.

At present, the base spread price has gradually become the mainstream.

At present, the mainstream long-term association of iron ore is still based on Platts index pricing, the port spot has Platts index as the benchmark of the dollar price and RMB price. In the past two years, some steel mills have also been trying to carry out spot spread trade based on iron ore futures in mines or iron ore traders. In the future, iron ore pricing benchmarks will be diversified. Although the short-term basis trade based on Dashang iron ore futures is still in its infancy, it has its own characteristics and advantages of risk management, and it is also the mainstream pricing model of international commodities. In the later stage, with the familiarity and understanding of steel mills and traders, it should gradually go deep into the pricing of iron ore trade.

It is understood that at present, steel companies also often use the trade method of base price difference in purchasing iron ore. Wang Qiang, general manager of Cargill Investment (China) Co., Ltd. (hereinafter referred to as Cargill), told Futures Daily that basis trade compared with traditional trade, when entity enterprises face their own risk management problems, some tools can only help them solve hedging problems in a general direction and cannot match their actual cargo flow. However, the basis can not only play a flexible price management ability, but also has the characteristics of seamless docking, so it has become a very effective risk management tool.

In fact, compared with traditional trade, the biggest advantage of basis trade is that it allows operators to make decisions on supply arrangement and price locking respectively.

Operators can book the supply of all the means of production in advance according to the needs of production, and then flexibly choose the time and price according to the transaction point of view. When the downstream wants to lock in the monthly average price, it will settle according to the monthly average; when it is bullish on the market price, it can put up an order in advance to lock in the low cost; when it is bearish on the market price, use the locked supply first, and wait for the market to fall to the target point. Then hang a single point to open a fixed price.

Since the beginning of this year, affected by the epidemic, iron ore prices have fluctuated greatly. In the face of this situation, what is the change in the demand for basis trade compared with previous years?

A person from the Futures Department of Hegang Group said that since the beginning of this year, the iron ore basis trade has been widely recognized by the industry, and the scale of the basis trade in the market is also steadily increasing. Hegang Group has been in the forefront of domestic iron and steel enterprises in using the futures market to manage risks, especially in carrying out iron ore basis trading business.

The basis trading business of Hegang Group integrates with the traditional purchasing and sales model and complements each other. As a class A trader on the basis trading platform of large trading houses, the basis trading business is also steadily improving. The procurement of base pricing of raw materials greatly reduces the fluctuation of purchasing prices. The adoption of basis pricing trade to downstream customers not only expands the trade volume of foreign sales, but also provides an opportunity for customers to use basis trade to manage procurement price risk, so as to achieve the goal of win-win.

Since the beginning of this year, the trading activity of the basis trade has increased significantly, and the participants of the whole market have extended from traditional traders to mines, steel mills, investment customers and so on. In the case of Cargill, the total volume of basis trades from January to May 2020 was more than 1.7 million tons, an increase of 50% over the same period last year.

It is reported that in the field of basis, Cargill cooperates with different types of demand sides, such as steel mills, traders, financial institutions and so on. The basis contract has different contract mechanisms, and part of the basis contract is also known as the point price contract. The use of the point price contract with the subject matter of the big business is one of the main tools used by Cargill at present. When Cargill cooperates with steel companies, steel companies can use point-price contracts as an alternative to long-term association procurement. In addition, Cargill also cooperates with trading enterprises, in which case, trading companies can use point-price contracts as trading tools, because many traders themselves take the basis as the trading perspective, so basis contracts can directly help these enterprises to achieve trading purposes, without the need to operate at both ends of futures and spot, which is why basis contracts are popular in many kinds of spot transactions. In addition to the point price contract, Cargill also has the basis option business, because the volatility of the basis is less than that of the subject matter itself, so it can make options on the basis of the spread to help financial institutions or investors express more complex and accurate trading viewpoints and help traders realize position hedging.

The reporter learned that in late March this year, the first mine Dachang Metal (Liu'an Steel Plant) (hereinafter referred to as the first big mining industry) should prepare the production raw materials before May Day in advance. On March 26, using-78 yuan / ton as the cash basis of iron ore, we purchased 50,000 tons of gold Bubba powder from Cargill, which will be delivered in Lianyungang at the end of April. In April, steel mills worried that iron ore futures 2005 contracts would be relatively strong, so they applied to Cargill to change the basis from 2005 contracts to 2009 contracts. After negotiation, it was agreed to move the position according to the market price difference of 5Mu9 contract price, and a supplementary agreement was signed accordingly. Finally, the first major mining industry put up orders on April 24th, 26th and 27th respectively according to the production pace, locking in procurement costs.

"in this basis transaction, the first major mining industry first arranged the supply in advance, and then locked the price at the right time according to its own production pace. Let the steel mills separate the operation when arranging the supply and cost locking, which is more flexible and controllable. " Wang Qiang said that basis trading provides a new perspective for iron and steel enterprises in operation and management, and iron and steel enterprises can better layout supply and organize production arrangements through the effective use of basis tools. Take the point price contract as an example, after carrying out the basis trade, the advantages that iron and steel enterprises can gain, including the ability to avoid the risks related to exchange rate changes, because the pricing contracts ordered by big businessmen take RMB as the pricing basis, which is in line with the sales valuation basis of most steel mills, so it can avoid exchange rate risk. The uncertainty of the arrival time can be avoided, because the spot price contract usually takes the spot at the port as the subject matter, so the agreement on the delivery time between the buyer and the seller is more secure, and the steel mills can determine the rhythm of use accordingly; it can avoid the risk of changes in import profits, especially in the case of iron ore import losses, and can help enterprises to lock in the variety premium of minerals.

A few years ago, domestic steel companies suffered unspeakably because of the constraints of foreign mines. Nowadays, the trading volume of the domestic port iron ore RMB spot market is also very huge, and the participants are more diverse than the US dollar market.

With the continuous growth of domestic demand for iron ore and the continuous expansion of the RMB trade market for iron ore, the limitations and shortcomings of traditional Platts index pricing are also gradually exposed. For the future, China, as the world's largest buyer of iron ore, will be able to better meet the real demands of iron ore participants by introducing RMB-denominated settlement. " Guotai Junan futures iron ore researcher Ma Liang said.

Looking forward to the future, the era of buyer pricing is coming.

Now, after promoting RMB settlement and pricing, Baowu Iron and Steel Group is the first domestic steel company to achieve cross-border settlement of iron ore transactions with the world's three largest iron ore suppliers.

Cai Yongzheng said that the settlement and pricing of RMB will help to alleviate the control of the risk of exchange rate fluctuations in import and export trade in the iron and steel industry and the problem of foreign exchange balance. In the import and export trade of most steel mills, the foreign exchange expenditure on the purchase of iron ore is much larger than the foreign exchange settlement income of steel exports, and the foreign exchange revenue and expenditure is often in a state of imbalance, forcing steel mills to invest more time and energy in controlling foreign exchange fluctuations and maintaining foreign exchange balance, as well as risk management costs. However, the use of RMB cross-border settlement for iron ore imports helps to ease such contradictions.

Iron ore is gradually priced in RMB, and the attitude of the mine is also positive. Affected by the epidemic, this is particularly important in the context of a recession in the global economy. Of course, it will take some time to form a trend, and there is a process that steel mills are familiar with and grope for, especially the lack of professional teams and systems for derivatives applications in most steel mills, but on the whole, it is mutually beneficial to steel mills, mines and traders, and it is not difficult to promote it in the later stage, but it just needs a process of gradual summary and promotion.

It is reported that iron ore futures are actively traded. In 2019, the daily average turnover of iron ore, coke and coking coal futures was 1.22 million, 230000 and 94000 respectively, equivalent to 122 million tons, 23 million tons and 5.62 million tons of spot respectively. Within the statistical range, there are more than 100 steel mills, more than 1300 traders and some mines participating in it, with a large number of market participants and active transactions. Iron ore futures adopt RMB pricing and settlement and physical delivery, the futures market is closely linked, the futures price is highly representative, and the correlation of the current price is more than 0.9, which provides a good market environment for enterprises to carry out hedging operation.

In order to promote futures pricing and RMB pricing for iron ore, large trading houses have been promoting "basis trade" pilot projects for iron ore and other varieties since 2017. By 2019, a total of 23 coal and coke steel enterprises have participated in 15 iron ore pilot projects, with a trade volume of more than 1.5 million tons. In September 2019, Dashi also launched a basis trading platform to further serve and support futures pricing by enterprises in industries such as iron and steel. By the end of May 2020, 85 iron ore basis trading transactions on the platform had been made, with a transaction value of about 1.003 billion yuan.

A reporter from the Futures Daily learned that iron ore is also the first international trading variety among black commodities, and the big trading house has actively launched a basis trading platform that is convenient for buyers and sellers to match and quote transactions, which is an important manifestation of the opening up of the market to the outside world. not only attract global customers to participate, the market scale will be larger, but also domestic and foreign industrial customers and investors trade on the same platform. Thus promoting the formation of a more open, transparent and globally representative benchmark for trade pricing. In the long run, it will help enterprises in the industry to play a risk aversion function and improve the efficiency of risk aversion.

At the same time, the introduction of foreign investors has enhanced the influence of iron ore futures prices and ultimately affected trade pricing. At the same time, although the US dollar is used as a margin, pricing and clearing are denominated in RMB, which once again contributes to the internationalization of RMB. With the introduction of iron ore cash settlement contract, there will be more indexes or targets denominated in RMB in iron ore pricing, and domestic enterprises will have a greater say in iron ore pricing power.

China is the largest buyer of most of the world's major commodities and the world's largest demander. Take iron ore as an example. China imports more than 1 billion tons of iron ore a year, accounting for 75 per cent of the global iron ore trade market. The huge spot demand in China provides an important foundation for the derivatives market. At the same time, China also has a more and more mature financial derivatives market for related commodities, such as iron ore futures has become the world's largest iron ore derivatives market since it was listed. In addition, in recent years, China has vigorously promoted the internationalization of RMB, the status of RMB in international pricing and settlement has been continuously improved, and the domestic derivatives market has also accelerated the pace of opening up to the outside world. the introduction of the internationalization of iron ore also facilitates the further participation of international capital in iron ore futures.

With years of smooth operation, the iron ore futures system has become more and more perfect, the recognition of all market participants has also been improved, and the number of entity enterprises using iron ore futures for hedging and basis trading has been increasing. With reference to the successful experience of international mainstream mature commodities, Dashang iron ore futures has become an important reference for quotation in the spot market, giving full play to the function of avoiding risks and discovering prices.

With the deepening of the integration of industry and finance, futures pricing will be the inevitable trend of the commodity market in the future.

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